A Review of Build-Operate-Transfer for Infrastructure Development: Some Lessons for Policy Reform Gilberto M

Philippine Institute for Development Studies Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas A Review of Build-Operate-Transfer for Infrastructure Development: Some Lessons for Policy Reform Gilberto M. Llanto DISCUSSION PAPER SERIES NO. 2008-25 The PIDS Discussion Paper Series constitutes studies that are preliminary and subject to further revisions. They are be- ing circulated in a limited number of cop- ies only for purposes of soliciting comments and suggestions for further refine- ments. The studies under the Series are unedited and unreviewed. The views and opinions expressed are those of the author(s) and do not neces- sarily reflect those of the Institute. Not for quotation without permission from the author(s) and the Institute. September 2008 For comments, suggestions or further inquiries please contact: The Research Information Staff, Philippine Institute for Development Studies 5th Floor, NEDA sa Makati Building, 106 Amorsolo Street, Legaspi Village, Makati City, Philippines Tel Nos: (63-2) 8942584 and 8935705; Fax No: (63-2) 8939589; E-mail: [email protected] Or visit our website at http://www.pids.gov.ph A Review of Build-Operate-Transfer for Infrastructure Development: Some Lessons for Policy Reform1 Gilberto M. Llanto2 Philippine Institute for Development Studies Summary The Philippines has used the BOT law, as amended to motivate private sector provision of infrastructure. Using examples from selected BOT projects in the country, the paper pointed out key issues constraining the successful implementation of the BOT approach to infrastructure provision. It also indicated several factors that were instrumental in forging an effective public- private partnership in BOT projects. The paper pointed out the need to address various issues, starting from the legal framework to the level of responsibilities of the government institutions that are involved in the project cycle, i.e., from project entry level to implementation and completion. Improvements should be introduced at the policy, legal and institutional frameworks in order to improve the usefulness of this approach to infrastructure development. Key words: Build-operate-transfer, public-private partnership in infrastructure, contracts, risk-sharing, subsidy, guarantees, arbitration, dispute settlement I. Introduction This paper has a twofold objective: (a) to review the experience of the Philippines with the utilization of the BOT approach for infrastructure development and (b) to draw key lessons and recommend policy reforms on how to improve the use of this strategic instrument for infrastructure provision. The paper is organized into five sections. After a brief introduction section 2 gives an overview of infrastructure in the Philippines. Section 3 provides an analytical framework of Build-Operate-Transfer (BOT) as an approach for providing infrastructure and how it is used by developing countries such as the Philippines to provide much-needed infrastructure. Section 4 analyzes the main issues and lessons in BOT implementation and uses case studies of BOT projects in the Philippines to illustrate key points. The lessons are traced through a discussion of the project cycle or the different stages of the BOT process. The case studies highlight the differential experience with BOT as an approach to infrastructure provision: both failed and successful projects are used to illustrate key points in the Philippine experience with the BOT approach. Time and space limitation forced the paper to simply sketch in broad strokes, so to speak, the various policy issues that the government has to address in order to improve public-private sector participation (PPP) in infrastructure in general and BOT implementation in particular. A more extensive and in-depth study of BOT projects, which can overcome the limitations of drawing lessons from a few simple case studies, should perhaps be done in the near future by other researchers. The last section provides concluding remarks and some policy recommendations. The globalization of production and distribution has compelled countries to have efficient infrastructure in order to be able to have substantial participation in global trading and production networks. Fabella (1996) tells the story of Taiwan, which followed a two-pronged strategy: improving macroeconomic stability and the provision of a competitive infrastructure. Once these conditions were met, firms on the technological frontier came and operated. Inefficient infrastructure creates a serious bottleneck and impediment to trade and growth and thus, there is a drive to meet the 2 infrastructure gap or to make more efficient existing infrastructure in many countries in East Asia. On the other hand, efficient infrastructure reduces transaction costs and creates value added for producers and consumers. It links producers to the global supply chains and distribution system, thereby creating access to discriminating global markets for goods and services. The rapidly developing countries in East Asia that have made substantial investments in power, telecommunications, transport and production technology have surged ahead of other, non-investing, developing countries (Llanto 2004 and 2007b)3. The provision of infrastructure services, that is, electricity, water, telecommunications, roads, railroads, ports and airports, is not an end itself. Those infrastructure services are indirect inputs to the provision of goods and service and they impact significantly in the productivity, cost and competitiveness of the economy (Guasch, Laffont and Straub 1993); thus they matter for economic growth (Canning (1998), Calderon, Easterly and Serven (2002); Calderon and Serven (2002). A 1 percent increase in the stock of infrastructure can increase GDP by up to 0.20 percent (Guasch, Laffont and Straub 1993). The growth of international trade and rapid urbanization underscore the need to cut costs, increase efficiency and competitiveness wherein the quality of infrastructure matters a lot. The limited coverage and quality of some Asian countries’ infrastructures are hindering their efforts to achieve international competitiveness4 The key role of infrastructure in economic growth cannot be ignored. A recent study done by a consortium of researchers under the World Bank, the Asian Development Bank and the Japan Bank for International Cooperation (2005) substantiates the decisive role that infrastructure has played in growth and poverty reduction in East Asia and the Pacific. Empirical studies testing the public capital hypothesis indicated that infrastructure has a positive and significant impact on growth and productivity. Canning and Pedroni (2004) investigated the long run consequences of infrastructure provision on per capita 3 income in a panel of countries over the period 1950-1992. Their results provide clear evidence that in the vast majority of cases infrastructure does induce long run growth effects although there is a great deal of variation in the results across individual countries. Summarizing the results of various estimates5, Gramlich (1994) and Sturm and De Haan (1995) found output elasticities with respect to public capital of around 0.3. Wang (2002)’s estimates for seven East Asian countries for the period 1979-1998 indicated an average elasticity of 0.2% of private production to a 1% increase in public capital. On the other hand, there still is debate “about whether infrastructure provision actually fosters economic development or whether it is provided as a product of the economic development process (Button, 1998)6. A different view was that while there is a definite link between infrastructure investment and economic growth, the causality in either direction has not been established. Thus, physical infrastructure can be regarded as form of “complementary capital” that requires the existence of available productive capital (whether physical or human) for investment (and innovation) in order to realize the economic growth potential. Infrastructure in itself can only develop, not create economic potential but only where appropriate conditions exist (O’Fallon 2003). Notwithstanding the lively debate among different researchers on the link between infrastructure and growth, the preponderance of empirical evidence shows that inadequate supply of infrastructure or the unreliability of infrastructure services may constrain investments of productive capital and lead to a restriction or reduction of output There are too many pieces of evidence supporting the significant impacts of infrastructure on productivity and growth that are difficult to ignore (Rodriguez, 2006). The majority of studies trying to establish a linkage between (public) investments or capital and economic growth indicate that (a) public capital is complementary and promotes private capital formation, (b) core infrastructure such as roads and railways, tend to have the most impact on productivity, and (c) the direction of causation is from public capital to productivity and not the other way around (Infrastructure Canada, 2007). A recent empirical paper pointed out that infrastructure acts as a major driver for growth and poverty reduction in the Philippines and that infrastructure is a significant 4 determinant of economic growth on an aggregative basis and also at the sub-national level (Llanto, 2008). The paper found evidence that infrastructure could be an important conditioning variable in regional convergence. Llanto’s results indicated the importance of investment in human capital (education)

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